TRIN - Horizon Technology: New Year More Monthly Dividends

2024-01-15 08:10:00 ET

Summary

• Horizon Technology Finance offers investors monthly dividend payments, providing recurring income to match fund living expenses.
• The stock has performed well, outperforming the S&P 500 and other peers in the past decade.
• HRZN has a healthy payout ratio and potential for special dividends due to NII growth, and could benefit from elevated funding needs amidst a slow IPO market.

There comes a time in many investors' lives where they grow weary of frequently trading in and out of stocks for capital gains (and having to manage estimated tax payments on those gains), and instead opting in favor of generating recurring income. What's even better is if a stock pays monthly, helping the investor to match fund payments such as credit card bills, utilities, mortgage, and rent.

This brings me to Horizon Technology Finance ( HRZN ), which offers investors just that. I last covered HRZN here with a 'Buy' rating back in October, highlighting its healthy balance sheet and plenty of spillover income on the books.

The stock appeared to be undervalued at the time, and it appears that the market has agreed, with HRZN's stock rising by 14% since then (17% total return including dividends), outstripping the 11.5% rise in the S&P 500 ( SPY ) over the same timeframe. In this article, I provide an update and discuss whether if the stock remains appealing at present, so let's get started!

Why HRZN?

Horizon Technology Finance is an externally-managed BDC that invests in growth segments of the economy like Technology and Life Sciences/Healthcare Technology. This is similar in profile to other BDCs like Hercules Capital ( HTGC ) and Trinity Capital ( TRIN ).

HRZN is well-balanced in that its investments are evenly distributed between Tech and Life Sciences, with the remainder going to Sustainability and Healthcare Information Services. Most of its investments (44%) are centered around the West Coast, and as shown below, most (63%) are in a sweet spot of their expansion phase, which comes after having an established business model.

Notably, HRZN has performed well for investors over the past decade. This is reflected by its 161% total return, slightly higher than the 159% return of the S&P 500. While peer HTGC has given even higher returns, HRZN has outperformed the VanEck BDC Income ETF ( BIZD ) and externally-managed peer TriplePoint Venture Growth ( TPVG ), as shown below:

Meanwhile, HRZN continues to perform rather well, generating a high 16.1% average debt portfolio yield over the trailing 12 months, driven by higher interest rates and a funding vacuum since the collapse of Silicon Valley Bank last year. Yields have continued to creep up as HRZN now generate a 17.1% annualized yield based on third quarter results.

HRZN was also able to grow its investment portfolio by 15% YoY funded in part by at-the-market equity offerings that were done at prices above its NAV per share, resulting in accretive growth. This, combined with higher interest rates, contributed to net investment income per share growing to $0.53 per share in the third quarter, up from $0.43 in the prior year period.

This results in a very healthy payout ratio of just 62%, based on the current regular dividend rate of $0.33 per quarter (paid at $0.11 monthly). The low payout ratio (by BDC standards) means that HRZN has plenty of retained capital with which it can use to continue to pay special dividends. As of the last reported quarter HRZN had $1.23 per share in spillover income, which if paid out immediately, would result in a 9.1% one-time yield based on the current share price of $13.52.

Risks to HRZN include markdowns in select portfolio investments, which caused NAV/share to drop to $10.41 as of Q3 from $11.66 in the prior year period. As shown below, this marks the first meaningful drop in NAV/share since 2017.

It appears however, that most of this is related to an unrealized loss due to asset value markdown, with one of them being Evelo Biosciences, which is a life sciences company that had two unfavorable trial outcomes for drugs in its pipeline last year. However, favorable outcomes since during the fourth quarter gives indication that HRZN could recover a meaningful if not all of its investment, as noted below during the last conference call :

Subsequent to the end of Q3, Horizon received an additional cash paydown of $11 million from Evelo with the $5 million paydown Horizon received from Evelo early in the third quarter, Horizon has received a total of $16 million in principal repayments on its Evelo debt investments in 2023.

In addition, we are working closely and collaboratively with the company as it seeks strategic alternatives to maximize the value of its core technology platform. Overall, we are closely monitoring all of our portfolio companies and are working with their management teams, investors and other stakeholders to assist them in the challenging macro and venture capital environment.

Moreover, the current environment for VC-backed companies remains challenging, as investment activity has been muted last year on back of a strong 2021 and 2022. Management noted that many VC backed investments are significantly overvalued in the current environment, resulting in challenges to raising capital for many VC firms, which management expects to last into the first part of this year.

However, the silver lining to decreased valuations and a tough IPO and M&A market is that BDCs like HRZN are finding higher demand for debt to fill the capital needs of their portfolio companies, and HRZN is seeing opportunities to invest in a number of quality names in its pipeline.

There is also potential for portfolio exits for HRZN in the life sciences space, as large drug companies have shown an appetite for acquiring smaller ones, as supported by recently announced acquisitions by Bristol Myers Squibb ( BMY ) and Merck ( MRK ). This could strengthen HRZN's investment portfolio standing as well as collect prepayment fees and rollover capital into other high yielding alternatives.

Importantly, HRZN carries a prudently managed balance sheet that supports growth opportunities. This is reflected by reasonably low leverage with a debt to equity of 1.12x, sitting well under the 2.0x regulatory limit. HRZN also has significant liquidity with $214 million comprised of cash and availability on revolving credit facilities.

Turning to valuation, I believe that HRZN is appropriately valued at the current price of $13.52 with a 9.8% dividend yield and a price-to-book ratio of 1.3x, sitting above that of peers TPVG and TRIN, as shown below.

While this valuation sits higher than HRZN's historical valuation of 1.0 to 1.2x, it's worth noting that it's elevated due to the recent write down of some of its assets, while net investment income remains strong. In the coming quarters, I would look for potential improvements to HRZN's NAV/share as it works its way through principal recovery on certain loans.

Investor Takeaway

Overall, HRZN presents a good monthly yielding choice with its growth in net investment income and healthy payout ratio. While there are risks associated with markdowns in portfolio investments, the potential for special dividends and exits through acquisitions provide opportunities for positive returns. With a prudently managed balance sheet and favorable market conditions for debt financing, HRZN is well positioned to continue growing its portfolio.

Considering all the above, I'm downgrading HRZN to a 'Hold' at present due to an appropriately valued share price with a historically high price-to-book ratio. In the meantime, investors get to collect a very well-covered 9.8% dividend yield that's paid monthly for potentially solid returns in 2024.

For further details see: